Consultant & Independent Contractor Agreements

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Consultant & Independent Contractor Agreements

Stephen Fishman

September 2017, 9th Edition

Get Your Contract in Writing

Whether you're an independent contractor or a business hiring one, it's important to put your agreement in writing. Complete with templates tailored to both sides, Consultant & Independent Contractor Agreements will help you craft an agreement that:

Product Details

Whether you’re an independent contractor or a business hiring independent contractors to work for you, it’s important to get your deal in writing. A written agreement will help to protect your rights, define expectations, and prove that there’s no employer-employee relationship.

Each chapter has two agreements—one geared towards the independent contractor and one geared towards the business hiring an independent contractor.

The 9th edition—completely updated to provide the latest rules and regulations—includes a new chapter on agreements for gig economy workers.

“Don't do anything without reading Consultant & Independent Contractor Agreements.... this book will help you understand the importance of written agreements and will show you exactly how to put your agreement together.’’ - Small Business Opportunities

“Worth the price for the information and forms that either directly affect creative consultants or can be adapted for editorial services.” - Freelance Writer's Report

“Illuminates some of the most important elements of this growing way to work…” - Boston Globe

Sample Chapter

Many businesses routinely use the services of nonemployees, whether those nonemployees are called consultants, independent contractors, vendors, or nothing at all. For convenience, these people will be referred to in this chapter as independent contractors or ICs. The businesses that hire ICs are sometimes referred to as hiring firms or clients.

Businesses can benefit significantly by treating a worker as an independent contractor rather than as an employee. But there are risks as well. This chapter provides an overview of these risks and rewards, and discusses how government agencies determine a workers’ true classification.

Resource: For a detailed analysis of all the legal issues involved in working with independent contractors, see Working With Independent Contractors, by Stephen Fishman (Nolo).

Benefits and Drawbacks of Using Independent Contractors

A hiring firm that classifies workers as independent contractors reaps many financial and other benefits. But misclassifying an employee as an IC can also be costly.

Benefits of Using Independent Contractors

The main reason most businesses use independent contractors is to save money. In addition to paying a salary, consider the following expenses and paperwork that a business has to deal with when it hires an employee instead of an independent contractor:

Federal tax withholding. The employer must withhold federal income tax from the wages paid to an employee. Each year, the employer must give the employee an IRS Form W-2, which shows how much he or she earned and how much was withheld.

Social Security and Medicare taxes. Both the employer and the employee have to pay a share of Social Security and Medicare taxes. These taxes must be paid with the withheld federal income tax.

State taxes. Employers must also pay state unemployment taxes and, in most states, withhold state income taxes from employees’ paychecks.

Workers’ compensation insurance. Employers usually must provide workers’ compensation insurance coverage for employees in case they are injured on the job.

Employment benefits. Although they are not always legally required to do so, most employers give their employees sick leave, paid holidays, and vacations. More generous employers also provide pension benefits for their employees.

Healthcare insurance. The Affordable Care Act, popularly known as Obamacare, requires all employers with 50 or more full-time employees (or the equivalent in part-time employees) to provide their employees with health insurance meeting minimum standards or pay a penalty to the IRS. Because the current administration has promised to eliminate this employer mandate, the future of this law is unclear. However, even if it is eliminated, employees generally expect to be provided with some form of health insurance coverage by their employers. By contrast, ICs are never provided with health insurance coverage.

Office space and equipment. An employer normally provides an employee with office space and whatever equipment is necessary for the job.

Other Employment Laws. Federal and state laws provide employees with a host of legal protections, including the right to unionize and bargain collectively (enforced by the National Labor Relations Board); laws on minimum wage, overtime, and child labor protections (enforced by the U.S. Department of Labor); and laws barring discrimination in employment (enforced by the Equal Employment Opportunity Commission). Almost none of these laws apply to ICs.

All of these items add enormously to the cost of hiring and keeping an employee. Typically, more than one-third of all employee payroll costs goes toward Social Security, unemployment insurance, health benefits, and vacation.

A business incurs none of these obligations when it hires an independent contractor. It need not withhold or pay any taxes. Perhaps most importantly, the hiring firm need not provide an independent contractor with health insurance, paid vacation time, or any other employee benefits.

A business that hires an IC only needs to report payments to the IC by filing Form 1099-MISC with the IRS. And the business doesn’t even have to file this form if the IC is incorporated, is paid less than $600 in a calendar year, or is paid electronically—for example, through PayPal.

There is another important reason businesses often prefer to use independent contractors: to avoid making long-term commitments to workers. An independent contractor can be hired solely to accomplish a specific task, which allows a business to obtain specialized expertise for a short time. The hiring firm need not go through the trauma, severance costs, and potential lawsuits brought on by laying off an employee.

Drawbacks and Risks of Using Independent Contractors

You might now be thinking, “I’ll never hire an employee again; I’ll just use independent contractors.” Before doing this, you should know that there are some substantial drawbacks and risks involved in using independent contractors.

Advantages of hiring employees

Even though there are many financial benefits to using ICs rather than employees, companies continue to hire employees. There are many good reasons for this, including the following:

When you hire employees, you can provide them with detailed training on how to do the job just as you want it done. You can also closely supervise and otherwise control the way the employees perform on the job. This is something you can’t do with an IC. Instead, ICs must be left alone to perform the agreed-upon services without substantial help or interference from you. (See “Workers Who Qualify as Independent Contractors,” below.)

Ordinarily, employees will not be working for your competitors while they’re working for you. In contrast, an IC you hire today may go to work for a competitor tomorrow.

When you hire employees, you can depend on having the same workers available day after day. Although it may not be as true today as it once was, generally, employees who are well treated can be relied upon to stick around. In contrast, ICs have no loyalty to anyone but themselves and their own bottom line. Having workers constantly coming and going can be inconvenient and disruptive. And the quality of work you get from different ICs may be uneven.

Government scrutiny

Another reason businesses continue to hire employees is fear of the IRS and other government agencies. The IRS and most states want to see as many workers as possible classified as employees, not as independent contractors. This way, the IRS and states can immediately collect taxes based on automatic and involuntary payroll withholding, rather than wait for ICs to pay estimated taxes voluntarily four times a year.

Because no taxes are deducted from their pay, ICs have many more opportunities to evade taxes than do employees. Moreover, substantial numbers of ICs habitually underreport their income to the IRS. This is something an employee can’t do, because employers must report all employee payments to the IRS on Form W-2. In short, the government gets more tax money faster when workers are treated as employees rather than as ICs.

If the IRS concludes that an employer has misclassified an employee as an independent contractor, it may impose substantial assessments, penalties, and interest against the employer. Being ordered to pay massive amounts of back taxes and penalties can easily put a small company out of business.

An employer’s woes do not necessarily end with the IRS. If the state tax agency, unemployment agency, or workers’ compensation agency suspects that workers have been misclassified as ICs, they may also audit the employer and order it to pay back taxes or unemployment or workers’ compensation insurance. Moreover, several states, including Colorado, Delaware, Illinois, Indiana, Maryland, Minnesota, New Hampshire, New Jersey, Rhode Island, and Washington have adopted laws which make it fraudulent for an employer to “knowingly” misclassify its workers as ICs in order to avoid providing them with unemployment or workers’ compensation insurance, or to avoid having to comply with federal or state wage and overtime pay rules.

Worker misclassification lawsuits

The number of worker misclassification lawsuits in which workers allege violations of state or federal employment laws is growing. Many of these take the form of class action lawsuits in which plaintiffs’ lawyers represent tens, hundreds, or even thousands of similarly situated workers.

Workers Who Qualify as Independent Contractors

When you first hire a worker, it’s up to you to decide whether that person is an employee or an independent contractor. If you classify the worker as an IC and consistently treat the worker as such, you’ll obtain the benefits outlined above. However, your decision is subject to review by numerous government agencies, including:

the IRS

your state unemployment compensation agency

your state workers’ compensation agency

your state tax department (if your state has income taxes)

the U.S. Department of Labor

the National Labor Relations Board, and

your state labor department.

These agencies work independently of each other. Your classification decisions may be questioned by one, many, or all of them. You want to be able to satisfy all agencies that any worker you classify as an IC really is one. The Department of Labor has taken particular interest in the worker misclassification issue. It recently hired hundreds of investigators and other enforcement staff to undertake a “Misclassification Initiative” designed to recover back wages and other benefits from employers that misclassified their workers as ICs.

So when is a worker an IC? Quite simply, whenever the worker is running an independent business and you treat that person accordingly. Good examples of ICs are professionals with their own practices, such as doctors, lawyers, dentists, and accountants. However, a person doesn’t have to be a professional with an advanced college degree to be an IC. So long as a worker is running a business and you treat the worker as an independent business, then the worker can be an IC.

To decide whether a worker is an independent businessperson or an employee, most government agencies assess the degree of control that the hiring firm has over the worker. Independent contractors maintain personal control over the way they do the work contracted for, including the details of when, where, and how the work is done. The hiring firm’s control is limited to accepting or rejecting the final results of the work. An independent contractor is just that—independent.

Example: Ray, the owner of a new fast food joint called BetterBurger, hires Sal, a graphic designer, to design a logo for advertisements, menus, and napkins. Even if he wanted to, Ray couldn’t control the details of how Sal performs this service because Sal works at his own office miles away from BetterBurger. Sal provides his own tools, sets his own work schedule, and decides how to design the logo. Ray’s control is limited to accepting or rejecting Sal’s final result—that is, he can refuse to pay Sal if he doesn’t like the design. Sal is clearly an IC, not Ray’s employee.

On the other hand, if you have the right to control how the worker does the job, that worker is an employee. This is so whether or not you actually exercise that right—that is, it doesn’t matter if you in fact decline to control the details of how the worker does the job.

And it makes no difference whether a person works only part time. Even a part-time worker will be considered an employee if the employer has the right to exercise control.

Example 1: Mary takes a job as a hamburger cook at BestBurger. BestBurger personnel train her carefully in how to make a BestBurger hamburger, including the type and amount of ingredients to use, the temperature at which the hamburger should be cooked, and so forth. Once Mary starts work, BestBurger managers closely supervise how she does her job.

Mary is BestBurger’s employee. Virtually every aspect of Mary’s behavior on the job is under BestBurger’s control—including what time she arrives at and leaves work, when she takes her lunch break, what she wears, and the sequence of the tasks she must perform. If Mary proves to be an able and conscientious worker, her supervisors may not look over her shoulder very often, but they have the right to do so at any time.

Example 2: BestBurger has been discovered by the gourmet burger crowd, who are demanding a fitting end to their elegant meal. BestBurger looks for a pastry chef and decides on Antoine. Antoine makes delectable pastries in his commercial kitchen for several restaurants in town. He agrees to deliver to BestBurger one dozen fruit tarts and 15 cakes every morning, but the ingredients and presentation are up to Antoine. Since he controls the production in every important respect, Antoine is an independent contractor.

If You Want to Be a Supervisor, You Must Be an Employer

When you classify workers as ICs, you relinquish your right to closely supervise them. ICs must be left more or less alone to perform the agreed-upon services without substantial guidance or interference.

Not all hiring firms are comfortable about granting such a high degree of autonomy to people who perform services for them. If you want to control how a worker performs, you should classify the worker as an employee.

Once you’ve decided that you are not going to have the right to control a worker, how do you make it clear that the person is a bona fide independent contractor? The government agencies you have to deal with can’t look into your mind to see whether the right to control exists, nor will they merely take your word for it. They will rely primarily on indirect or circumstantial evidence indicating control or lack of it—for example, whether you provide a worker with tools and equipment, pay by the hour, or have the right to fire the worker. This is what government auditors will be asking you about if you’re audited.

Government auditors examine a number of different factors to determine whether a hiring firm has the right to control a worker. Different agencies use different sets of factors. The IRS looks at 14 main factors. Other agencies examine fewer factors. (See the “Worker Classification Factors” chart, later in this chapter, for specific information about who looks at what.)

Forms to Help You Classify Workers

To supplement the information in this chapter, we provide two forms that will help you ensure that the workers you hire are independent contractors. These forms are not legally required, but they can be a big help—both for your own purposes and for defending your case to a government agency, should it come to that. If you use these forms, be sure to keep them in your independent contractor files:

Independent contractor questionnaire. Ask prospective independent contractors to complete this questionnaire. It elicits the information that you will need to classify the worker, and it can serve as excellent evidence for the correctness of your classification.

Documentation checklist. This asks the independent contractor to provide you with copies of written records that will help show the worker is an independent contractor, not an employee. Few contractors will be able to provide all of the documents on the checklist, but the more you can get, the better.

You can download both of these forms (and all other forms in this book) from Nolo.com (for details, see Appendix A). You can also find copies
in Appendix B.

As you read through this section, don’t be overwhelmed—you don’t need to memorize it, and it’s not necessary to satisfy every factor for a worker to be considered an IC. How much is enough? The best answer we can give you is that the factors considered by the agency involved—be it the IRS, a state unemployment compensation agency, or another agency—must weigh in favor of IC status. Obviously, the more factors that indicate IC status, the better off you’ll be if you’re audited.

Resource: For a detailed discussion of how various agencies determine whether someone is an IC or an employee, see Working With Independent Contractors, by Stephen Fishman (Nolo).

Making a Profit or Loss

Employees. Typically, employees are paid for their time and labor and have no liability for business expenses.

Independent Contractors. ICs can earn a profit or suffer a loss as a result of the services they provide. ICs are entrepreneurs. They make money if their businesses succeed but risk going broke if they fail. Whether ICs make money depends on how well they use their ingenuity, initiative, and judgment in conducting their business.

Example: Jack retires from his job as an actuary for a large insurance company and decides to become a professional golfer. He purchases $2,000 worth of golf clubs and qualifies for the Senior PGA Golf Tour. He pays his own traveling expenses and entrance fees for tournaments. If Jack plays well, he will win prize money and may earn a profit from his golfing. But if he plays poorly, he may earn nothing and lose money. How much money Jack makes or loses is entirely up to him. Jack is an IC and proud of it!

Working on Specific Premises

Employees. Employees must work where their employers tell them, usually on the employer’s premises.

Independent Contractors. Usually, ICs are able to choose where to perform their services.

Work at a location specified by a hiring firm implies control by the firm, especially if the work could be done elsewhere. A person working at a hiring firm’s place of business is physically within the firm’s direction and supervision. If the person can choose to work off the premises, obviously the firm has less control. On the other hand, the fact that a person works at home doesn’t necessarily mean he or she is an IC. Many employees work at home and telecommute.

However, many ICs perform tasks that can be done only at the hiring firm’s premises—for example, an IC painter or rug layer must perform the services on the client’s premises. In this event, this factor is not considered in determining the worker’s status.

Offering Services to the General Public

Employees. Employees offer their services solely to their employers.

Independent Contractors. ICs offer services to the general public.

Since they are independent businesspeople, normally ICs make their services available to the public. ICs often advertise and will work for anyone who agrees to their terms.

Right to Fire

Employees. Typically, an employee can be discharged by the employer at any time and for almost any reason.

Independent Contractors. An IC’s relationship with a hiring firm can be terminated only according to the terms of their agreement.

If you have a right to fire a worker at any time for any reason or for no reason at all, government auditors may conclude that you have the right to control that worker. The ever-present threat of dismissal must inevitably cause a worker to follow your instructions and otherwise do your bidding. This type of control is not present when both you and the IC know you can’t arbitrarily terminate the IC’s services without risking a lawsuit for breach of contract.

Furnishing Tools and Materials

Employees. Typically, employees receive all the tools and materials necessary to do their jobs from their employers.

Independent Contractors. Typically, ICs furnish their own tools and materials.

The fact that a hiring firm furnishes tools and materials, such as computers and construction equipment, tends to show control because the firm can determine which tools the worker is to use and, at least to some extent, in what order and how they will be used.

Sometimes, however, ICs have to use a hiring firm’s tools or materials. For example, a computer consultant may have to perform work on the hiring firm’s computers. The fact that the tools are provided in such a situation should be irrelevant.

Method of Payment

Employees. Usually, employees are paid by unit of time.

Independent Contractors. Typically, ICs are paid a flat rate for a project.

Workers who are paid by unit of time—for example, by the hour, week, or month—are apt to be classified as employees. This is because the hiring firm assumes the risk that the services provided will be worth what the worker is paid. To protect its investment, the hiring firm demands the right to direct and control the worker’s performance. In this way, the hiring firm makes sure it gets a day’s work for a day’s pay.

Generally, payment by the job or on a straight commission indicates that the worker is an IC. However, in many professions and trades, payment is customarily made by unit of time. For example, lawyers, accountants, and psychiatrists typically charge by the hour. Where this is the general practice, the method of payment factor will not be given great weight.

Working for More Than One Firm

Employees. Although employees can have more than one job at a time, employers can require loyalty and prevent employees from taking some alternative jobs.

Many employees have more than one job at a time. However, employees owe a duty of loyalty toward their employers—that is, employees cannot engage in activities that harm or disrupt their employers’ businesses. This restricts employees’ outside activities. For example, ordinarily an employee wouldn’t be permitted to take a second job with a competitor of the first employer. An employee who did so would be subject to dismissal.

Generally, ICs are subject to no such restrictions. They can work for as many clients or customers as they want. Having more than one client or customer at a time is very strong evidence of IC status. People who work for several firms at the same time are generally ICs because they’re usually free from control by any one of the firms.

Continuing Relationship

Employees. Employees have a continuing relationship with their employers.

Independent Contractors. Generally, ICs work on one project and then move on.

Although employees can be hired for short-term projects, this type of relationship is more typical of ICs. An employee usually works for the same employer month after month, year after year, sometimes decade after decade. Such a continuing relationship is one of the hallmarks of employment. Indeed, one of the main reasons businesses hire employees is to have workers available on a long-term basis.

Investment in Equipment or Facilities

Employees. Generally, employees have no investment in equipment or facilities, both of which are owned by their employers.

Independent Contractors. ICs have an investment in the equipment and facilities appropriate for their businesses.

This factor includes equipment and premises necessary for the work, such as office space, furniture, and machinery. It does not include tools, instruments, and clothing commonly provided by employees in their trade—for example, uniforms that are commonly provided by the employees themselves. Nor does it include education, experience, or training.

When a worker has made a significant investment in the equipment and facilities needed to perform the services, there is a good argument that the worker should be considered an IC. By making such a financial investment, the worker risks losing it if the business is not profitable. Also, the worker is not dependent upon a hiring firm for the tools and facilities needed to do the work. Owning the tools and facilities also implies that the worker has the right to control their use.

On the other hand, lack of investment indicates dependence on the hiring firm for tools and facilities; this is another hallmark of an employer-employee relationship.

Some types of employees typically provide their own inexpensive tools. For example, carpenters may use their own hammers, and accountants may provide their own calculators. Providing such inexpensive tools doesn’t show that a worker who is otherwise an employee is an IC instead. But a worker who provides a $3,000 computer or a $10,000 lathe is more likely to be considered an IC.

Business or Traveling Expenses

Employees. Employees’ job-related business and traveling expenses are paid by the employer.

Independent Contractors. Typically, ICs pay their own business and traveling expenses.

If the hiring firm pays a worker’s business and traveling expenses, the worker will often be viewed
as an employee. To be able to control such expenses, the employer must retain the right to regulate and direct the worker’s actions.

On the other hand, people who are paid per project and who pay expenses out of their own pockets are generally ICs. Workers who are accountable only to themselves for expenses are free to work according to individual methods and means—the hallmark of an IC.

Of course, some ICs typically bill their clients

for certain expenses. For example, lawyers and

accountants tend to bill clients for travel, photocopying, and other incidental expenses. This does not by itself make them employees, since their

clients do not control them.

Right to Quit

Employees. Normally, an employee may quit the job at any time without incurring any liability to the employer.

Independent Contractors. ICs are legally obligated to complete the work they agreed to do.

Most employees work “at will.” Unless there is an employment contract stating otherwise, they can quit whenever they want to without incurring liability, even if it costs the employer substantial money and inconvenience. And, conversely, they can be fired at will (see above).

ICs are legally obligated to complete the job they signed on to do. If they don’t, they are liable to the hiring firm for any losses caused by their stoppage.

Example: The Lazy Eight Motel hires John, a licensed building contractor, to construct a new wing. John agrees to complete the work by May 1. Halfway through construction, John receives a much more lucrative offer to work on a new office building. John stops work and abandons the project. Lazy Eight is forced to hire a new contractor to complete the wing. As a result, completion of the wing is delayed by several months. John is liable to Lazy Eight for the profit it lost due to his failure to complete the wing as agreed.

Instructions

Employees. Employers have the right to give their employees oral or written instructions that the employees must obey concerning when, where, and how they are
to work.

Independent Contractors. ICs need not comply with instructions on how to perform their services; they decide on their own how to do their work. They are, however, obliged to deliver the final product as called for in the agreement or contract.

Watch out—this matter of instructions can be tricky. That’s because there is no requirement that instructions actually be given to an employee. The IRS and other government agencies will focus instead on whether you have the right to give them. Even though you have not given a worker instructions, the IRS could conclude that you have set up the relationship so that you have the right to do so. The agency may view this power to instruct as an indication of employment status.

Fortunately, in many situations the issue of instructions won’t be problematic for IC status. If a worker is running an independent business and you are just one client or customer among many, it’s likely you don’t have the right to give the worker instructions about how to perform the services. Your right is usually limited to accepting or rejecting the final results.

Example: The local AcmeBurger has a plumbing problem. The manager looks in the yellow pages and calls Jake the plumber to come and fix the problem. Jake shows up with his assistant Tony. The manager explains the problem, and Jake gives him an estimate of how much it will cost to fix it. The manager gives the go-ahead, and Jake and Tony begin work. When the work is finished, the manager can refuse to pay if he thinks the plumbing has not been properly repaired. However, if he had presumed to tell Jake how to go about doing the plumbing repair, Jake would probably have told him to get lost and gone on to his next customer.

On the other hand, you probably will have the right to give instructions to workers who are not running an independent business and are largely or solely dependent upon you for their livelihood.

Example: Joe the tailor abandons his own tailor shop when he’s hired to perform full-time tailoring services for Acme Suits, a large haberdashery chain. Joe is completely dependent upon Acme for his livelihood. Acme managers undoubtedly have the right to give Joe instructions, even if they don’t feel the need to do so because Joe is such a good tailor.

Note that you may give an IC detailed guidelines as to the end results to achieve without destroying his or her status as an IC. For example, a software programmer may be given highly detailed specifications describing the software programs to be developed, or a building contractor may be given detailed blueprints showing precisely what the finished building should look like. Since these instructions relate only to the end results and not to how they must be accomplished, they do not turn the programmer and building contractor into employees.

Sequence of Work

Employees. Employees may be required to perform services in the order or sequence set for them by the employer.

Independent Contractors. ICs decide for themselves the order or sequence in which they work.

This factor is closely related to the right to give instructions. If a person must perform services in the order or sequence set by the hiring firm, this shows that the worker is not free to use discretion in working, but must follow established routines and schedules.

Often, because of the nature of the occupation, the hiring firm either does not set the order of the services or sets them infrequently. It is sufficient to show control, however, if the hiring firm retains the right to do so. For example, a salesperson who works on commission is usually permitted latitude in mapping out work activities. But normally the hiring firm has the discretion to require the salesperson to report to the office at specified times, follow up on leads, and perform certain tasks at certain times. Such requirements can interfere with and take precedence over the salesperson’s own routines or plans. They indicate control by the hiring firm and employee status for the salesperson.

Training

Employees. Employees may receive training from their employers.

Independent Contractors. Ordinarily, ICs receive no training from those who purchase their services.

Training may be done by teaming a new worker up with a more experienced one, by requiring attendance at meetings or seminars, or even by correspondence. Training shows control because it indicates that the employer wants the services performed in a particular way. This is especially true if the training is given periodically or at frequent intervals.

Usually, ICs are hired precisely because they don’t need any training. They possess special skills or proficiencies that the hiring firm’s employees do not have.

Services Performed Personally

Employees. Employees are required to perform their services on their own—that is, they can’t get someone else to do their jobs for them.

Independent Contractors. Generally, ICs are not required to render services personally; for example, they can have their own employees do all or part of the work.

Ordinarily, an IC doesn’t have to do all the work personally. This is part and parcel of running a business. For example, if you hire an accountant to prepare your tax return, normally the accountant has the right to have employee assistants do all or part of the work under supervision—a process known as delegation. However, the law of contracts imposes significant restrictions on an IC’s ability to delegate work that involves personal services—for example, painting a picture or creating another work of art.

Requiring someone whom you hire to personally perform all the work indicates that you want to control how the work is done, not just the end results. If you were only interested in end results, you wouldn’t care who did the work; you’d just make sure the work was done right when it was finished.

Hiring Assistants

Employees. Although employees may supervise and oversee the work of assistants, these assistants are hired and paid by the employer—ultimately, they work for the employer, not the employee.

Independent Contractors. ICs hire, supervise, and pay their own assistants.

Usually, government auditors will be very impressed by the fact that a worker hires and pays assistants. This is something employees simply do not do and is strong evidence of IC status because it shows risk of loss if the IC’s income cannot meet payroll expenses.

Set Working Hours

Employees. Ordinarily, employees have set hours of work.

Independent Contractors. ICs are masters of their own time; ordinarily, they set their own work hours.

Obviously, telling a worker when to come to work and when to leave shows that you have control over that worker.

Working Full Time

Employees. An employee may be required to work full time at the employer’s business.

Independent Contractors. ICs are free to work when and for whom they choose.

Requiring a worker to work full time indicates that you have control over how much time the worker spends on your job. In practice, it restricts that worker from working elsewhere.

Oral or Written Reports

Employees. Employees may be required to submit regular oral or written reports to the employer regarding the progress of their work.

Independent Contractors. Generally, ICs are not required to submit regular reports; they are responsible only for end results.

Submitting reports shows that the worker is compelled to account for individual actions. Reports are an important control device for an employer. They help determine whether directions are being followed or whether new instructions should be issued.

This factor focuses on regular reports detailing a worker’s day-to-day performance. It does not include the common practice among ICs of submitting infrequent interim reports to hiring firms when they are working on long or complex projects. These reports are typically tied to specific completion dates, timelines, or milestones written into the contract. For example, a building contractor may be required contractually to report to the hiring firm when each phase of a complex building project is completed. Submission of a report like this will not by itself make the contractor look like an employee in the eyes of the government.

Integration Into Business

Employees. Typically, employees provide services that are an integral part of the employer’s day-to-day operations.

Independent Contractors. Typically, ICs’ services are not part of the hiring firm’s day-to-day business operation.

Integration means that the workers are a regular part of the hiring firm’s overall operations. According to most government auditors, the hiring firm would likely exercise control over such workers because they are so important to the success of the business.

Example: Fry King is a fast-food outlet. It employs 15 workers per shift who prepare and sell the food. Jean is one of the workers on the night shift. Her job is to prepare all the french fries for the shift. Fry King would likely go out of business if it didn’t have someone to prepare the french fries. Since french fry preparation is a regular or integral part of Fry King’s daily business operations, Jean’s work is that of an employee.

By contrast, ICs generally have special skills that the hiring firm calls upon only sporadically.

Example: Over the course of a year, Fry King hires a painter to paint its business premises, a lawyer to handle a lawsuit by a customer who suffered from food poisoning, and an accountant to prepare a tax return. All of these things may be important or even essential to Fry King—otherwise it wouldn’t pay to have them done—but they are not a part of Fry King’s normal daily operations of selling fast food.

Skill Required

Employees. Workers whose jobs require a low level of skill and experience are more likely to be employees.

Independent Contractors. Workers with jobs requiring complex skills are more likely to be ICs.

The skill required to do a job is a good indicator of whether the hiring firm has the right to control a worker. This is because you are far more likely to have control over the way low-skill workers do their jobs than you do over the way high-skill workers do their jobs. For example, if you hire a highly skilled repair person to maintain an expensive and complex photocopier, you probably don’t know enough about photocopiers to supervise the work or even tell the repair person what to do. All you are able to figure out is whether the repair person’s results meet your requirements—that is, whether the photocopier works once the repairs are complete.

But when you hire a person to do a job that does not require high skills or training, such as answering telephones or cleaning offices, you are normally well qualified to supervise the work and give step-by-step directions. Generally, workers in such occupations expect to be controlled by the person who pays them—that is, they expect to be given specific instructions as to how to work, to be required to work during set hours, and to be provided with tools and equipment.

For these reasons, highly skilled workers are far more likely to be ICs than low-skill workers. But having an advanced professional degree or possessing unique skills does not automatically make that person an IC. The question of control must always be addressed. Corporate officers, doctors, and lawyers can be employees just like janitors and other manual laborers if they are subject to a hiring firm’s control.

Example: Dr. Welby leaves her lucrative solo medical practice to take a salaried position teaching medicine at the local medical school. When Dr. Welby ran her own practice, she was an IC in business for herself. She paid all the expenses for her medical practice and collected all the fees. If the expenses exceeded the fees, she lost money.

As soon as Dr. Welby took the teaching job, she became an employee of the medical school. The school pays her a regular salary and provides her with employee benefits, so she has no risk of loss as she did when she was in private practice. The school also has the right to exercise control over Dr. Welby’s work activities—for example, requiring her to teach certain classes. It supplies an office and all the equipment Dr. Welby needs. She is no longer in business for herself.

Worker Benefits

If you provide a worker with employee benefits, such as health insurance, sick leave, pension benefits, and paid vacation, it’s only logical for courts and government agencies to assume that you consider the worker to be your employee subject to your control. To keep the benefits, it’s likely that the worker would obey your orders. You’ll have a very hard time convincing anyone that a person you provide with employee benefits is not your employee.

On the other hand, typically you are not required or expected to provide an IC with any benefits other than payment for completing the work.

Tax Treatment of the Worker

Employees. Usually, employees have federal and state payroll taxes withheld by their employers and remitted to the government.

Independent Contractors. Ordinarily, ICs pay their own taxes.

Employers must withhold and pay federal and state payroll taxes for their employees, including Social Security taxes and federal income taxes. A firm that hires an IC ordinarily need not remit or withhold any taxes for the worker.

Treating a worker as an employee for tax purposes—that is, remitting federal and state payroll taxes for the worker—is very strong evidence that you believe the worker to be your employee and that you have the right to exercise control over the worker.

Intent of the Hiring Firm and Worker

Employees. Normally, people who hire employees intend to create an employer–employee relationship.

Some government agencies and courts also consider the intent of the hiring firm and worker. If it appears that they honestly intended to create an IC relationship, it’s likely that the hiring firm would neither believe it had control nor attempt to exercise control over the worker. One way to establish intent to create an IC relationship is for the hiring firm and IC to sign an independent contractor agreement like those in this book.

On the other hand, if it appears that you never intended to create a true IC relationship and merely classified the worker as an IC to avoid an employer’s legal obligations, then you probably had the right to control the worker.

Custom in the Trade or Industry

Employees. Workers who are normally treated like employees in the trade or industry in which they work are likely to be employees.

Independent Contractors. Workers who are normally treated like ICs in the trade or industry in which they work are likely to be ICs.

The custom in the trade or industry involved is important as well. If the work is usually performed by employees, employee status is indicated. And workers treated customarily as ICs may get the benefit of that custom, as long as there is in fact no employee-like control exerted over them.

Example: The long-standing custom among logging companies in the Pacific Northwest is to treat tree fellers—people who cut down trees—as ICs. Customarily, they are paid by the tree, receive no employee benefits, and are free to work for many logging companies, not just one. None of the logging companies withhold or pay federal or state payroll taxes for tree fellers. The fellers pay their own self-employment taxes. This long-standing custom is strong evidence that the workers are ICs.

Other Agencies, Other Tests

Not all government agencies use the right-of-control test described above to decide whether a worker is an IC or employee. Some workers’ compensation and labor law agencies use an economic reality test. Under this test, workers are employees if they are economically dependent upon the businesses for which they render services. This difficult-to-apply test is designed to protect low-pay and low-skill workers—that is, to find that such workers are employees for purposes of workers’ compensation and labor laws intended to help workers. (For a detailed discussion, see Working With Independent Contractors, by Stephen Fishman (Nolo).)

Special State Rules for Some Occupations

Many states have adopted special worker classification rules for workers in particular occupations—typically, those in which employees are commonly misclassified as ICs. The construction industry is most often singled out for special treatment (see Chapter 12). Other states have special rules for other occupations. For example, California requires all roofing companies to have workers’ compensation coverage, even if they have no employees. Additionally, real estate brokers in California are required to provide workers’ compensation coverage for their salespeople, even though they are usually classified as ICs under federal tax law.

When Written IC Agreements Are Vital

You could view every worker in America as being somewhere on an IC–employee continuum. At one end are workers who are clearly ICs. You have little to fear from government auditors when you hire such workers.

Example: You start a new business and hire Malcolm, a local certified public accountant (CPA), to perform accounting and tax preparation services. Malcolm has a well-established CPA firm that represents dozens of clients. He has several employees and his own office, and he advertises in the local yellow pages. Malcolm is running an independent business. There is no way Malcolm will be viewed as your employee by the IRS or any other government agency.

At the other end of the continuum are workers who are clearly employees. No matter what you call them, such workers will be classified as employees by the IRS and other government auditors.

Example: You hire Meg to perform bookkeeping services for your business. You pay Meg a monthly salary, provide her with office space at your workplace, reimburse her for all her expenses, and provide her with health insurance and sick leave. Meg works for you full time, and you closely supervise her work. Meg is your employee. She is not running her own business and is obviously subject to your control on the job.

But in between these two extremes, there is a vast middle ground where work relationships have some elements of employment and others of independence.

Example: Instead of hiring Meg to perform bookkeeping services for your business, you hire Nora. Nora has two other clients besides you. She works partly in your office and partly at home. You pay her by the hour and reimburse her for expenses. Is Nora an IC or your part-time employee? It’s hard to say for sure. This is something an IRS or other government auditor may question.

Obviously, if you want to hire an IC, you’d be better off hiring workers who clearly qualify as ICs. However, this is often not possible—perhaps the only person you can find to do the work doesn’t have all the indicia that shout “IC” to a government auditor. When workers fall into this uncertain middle ground, it’s most important to use a carefully drafted independent contractor agreement. While such an agreement can never make a worker qualify as an IC by itself, it can help tip the balance in favor of IC status in close cases.

However, don’t forget that a written agreement saying the worker is an IC won’t help you if it is abundantly clear that the worker is really an employee. A government auditor will disregard a written IC agreement that’s a sham.

Special Rules for Arizona

Effective August 6, 2016, Arizona law provides that a worker is legally presumed to be an IC for state law purposes if the IC completes, signs, and dates a “Declaration of Independent Business Status.” The Arizona statute has sample language to include in the declaration. (Ariz. Rev. Stat. Ann. § 23-1601.) A completed declaration gives rise to a legal presumption that the worker is an IC for purposes of Arizona unemployment compensation, workers’ compensation, and other state laws. However, the IC and hiring firm must substantially live up to the terms of the declaration. If the worker is actually treated as an employee rather than an IC, the declaration can be disregarded.

Use of the declaration is optional. If it is not used, the worker’s classification will be determined by state agencies using their normal tests. Additionally, the declaration does not establish any special legal presumption for federal law purposes. Thus, a worker who signs such a declaration will not be presumed to be an IC by the IRS, the U. S. Department of Labor, or other federal agencies.

How will you know if your situation falls within the great middle ground? If you answer “yes” to any of the following questions, the worker may still qualify as an IC, but it’s likely that the IRS or another government agency will question the worker’s status if you’re audited. In these situations, it’s vital that you use a written independent contractor agreement. Ask yourself:

Does the worker work for you full time?

Is the worker going to work for you for a substantial period of time?

Do you pay or reimburse the worker’s business or travel expenses?

Do you pay the worker by the hour or another unit of time?

Is the worker performing services you also pay employees to perform?

Can you terminate the worker at any time?

Do you provide the worker with materials, equipment, or facilities?

Does the worker work at your premises even though the work does not require it?

Do you require the worker to perform the services personally?

Are similar workers customarily treated like employees in your trade or industry?

Is the worker performing services that require little or no specialized skills?

You should use a written agreement if you are hiring a real estate salesperson or a door-to-door salesperson who sells consumer products. A special federal law provides that using such agreements automatically establishes such workers as ICs for IRS purposes. (See Chapter 8 of this book for door-to-door salesperson and real estate salesperson agreements.)

It is also highly advisable to use a written agreement if the worker is going to create a copyrightable work of authorship for you. This has nothing to do with the worker classification issue. Rather, a written agreement is necessary to clearly establish who will own the IC’s work product. In the absence of such an agreement, ICs could end up owning the work they create on your behalf. (See Chapter 11.)